National Institute of Economic and Social Research

Wednesday, 9 January 2013

Immigration as a growth strategy

[My chapter in the Fabian Society pamphlet "The Great Rebalancing: How to fix the broken economy", edited by Andrew Harrop, which also features chapters by Maurice Glasman, Stephany Griffith-Jones, Chi Onwurah, Duncan Weldon, Mariana Mazzucato, Vicky Pryce, and Chris Leslie].

What forms of supply-side reform would
do most to boost UK growth over the medium to long term? Bizarrely, much of the recent debate has
concentrated on reducing various forms of labour market regulation (procedures
for unfair dismissal, health and safety, etc).
The evidence base supporting such proposals is remarkably thin. The UK labour market, as many have observed,
is doing remarkably well. Hiring -
given economic conditions - is surprisingly healthy, and employment is rising,
despite weak or no growth . Labour market economists, and international
organisations like the OECD, agree that three decades of successful reform have
given the UK a flexible and generally well-functioning labour market, by
international standards. There is no reason to believe labour market regulation is currently a significant
barrier to job creation. This suggests that - while doubtless there are improvements that could be made
around the edges - there is little to gain from further wholesale
deregulation. Spain and Italy need
radical labour market reform; we don't.

But, looked at in a broader perspective, there is
one aspect of labour market regulation where sensible deregulation is urgently
needed, and could genuinely boost UK growth over the medium term. This is
immigration. Now immigration rules are not generally what either
economists or policymakers think of when they talk about labour market
regulation. But of course restrictions on those who want to come here, or
stay here, to take up employment or to look for a job are exactly that: they
are government regulations that change the way the labour market
functions.

So the changes to
skilled migration introduced by the government - a set of new burdensome
and bureaucratic rules and regulations, including a quota on skilled migrants
- are new labour market regulations. Indeed, in contrast to almost all
other such regulations, which are at least designed with an eye to ensuring
that the benefits to employers and employees outweigh the costs, these changes
were designed expressly to make it more difficult for businesses to employ
the workers they want.

As a consequence, they
will reduce growth and make us poorer. And these impacts, even according to the
government's own estimates, are potentially very large. As I said in my testimony to the Treasury
Select Committee after the 2011 Budget:

"The extra employment regulation that the Government
has imposed on employers wishing to employ migrant workers—the cap on skilled
migration—will, using the Government's own methodology, reduce UK output by
between £2 and 4 billion by the end of the Parliament."

This is not just a
result of the reduced size of the population; since the regulations are
designed to exclude skilled migrants, who tend to be more productive, they also
reduce average productivity and hence GDP per capita. None of this is news to economists; most of us,
wherever we are on the political spectrum, think that well-functioning
markets usually do a pretty good job of allocating resources. That goes for the
labour market too, so it is no surprise that liberal (in the true sense of
the word) immigration policies are good for the economy, and restrictive ones
are not. So
simply reversing the new regulations introduced by this government, let alone
further deregulation, could yield large gains. Moreover, in contrast to some
other policy changes that might promote growth, the fiscal impact would be
positive, not negative.

But this is not the end
of the story by any means. The estimates
above of the economic impacts, while significant, are still not that large
relative to the size of the UK economy. And one level, this is not surprising; in
standard “static” economic models, the impact of immigration is positive - to
the extent that immigrants are complements to natives - but relatively small.
And to the extent that immigrants are substitutes for natives then the impact
is essentially zero.

So it is often argued that the economic
impacts of migration - positive or negative - are likely to be small, with the
main impact being to increase both population and GDP, but with little impact
(over the medium to long run at least) on GDP per capita or unemployment and
employment rates.

However, this is a very static view of
the world; it does not reflect how economies actually work, or where growth
really comes from. To see this, we
merely need to observe that exactly the same is true of trade. This is not
surprisingly, since the underlying
mathematical structure of the basic models economists use to model trade and
immigration is identical. So, for example,
estimates of the benefits to the UK of completing the Doha round of multilateral
trade liberalisation are typically no more than 0.1% of GDP.

But of course most economists believe
that the economic benefits of trade are quite considerable, and that these static estimates are not the whole story or
even the main point; the benefits are dynamic and arise from competition and
specialization rather than simple static comparative advantage. We do not gain from free trade in, say, cars
with the EU because either we or the French or Germans have a fixed and static
comparative advantage in different types of car, so we can produce one
type of car better and they can produce
another; rather, because trade increases competition between different
producers, diversification of the supply chain across the EU, the incentive for
technological innovation, and all sort of other difficult to measure but
important effects that increase productivity in the medium to long term.

The same
is, in principle, likely to be true of immigration. Immigration is likely to have impacts on
productivity and growth over the medium to long term in a number of ways:

immigrants could bring different skills and
aptitudes, and transmit those to non-immigrant colleagues (and vice versa)

immigration could be complementary to trade in
goods and services (because of immigrant networks or for other reasons

workplace diversity (across a number of
dimensions) could increase (or decrease) productivity and innovation

Not all of these impacts are necessarily
positive: for example, it is well known that immigrants are
substantially more likely to be entrepreneurs or self-employed. This could be because
they are self-selected, so enterprising people are more likely to migrate; but
exclusion or discrimination might also force some migrants into
low-productivity self-employment. So what does
the evidence say?

Well, in
contrast to the well-established economic literature on the impact of migration
on labour markets, we have much less quantitative analysis on these topics.
What there is does, however, support the arguments above:

there is a considerable body of evidence in the
US that suggests that immigration is associated with increased innovation (for
example, that that immigrants are more likely to register patents, and that
this in turn leads to an increase in patent activity on the part of natives);
and with international trade and knowledge transfer, particularly in high-tech
industries;

Here in the UK, my NIESR colleague Max Nathan has
written a number of papers on similar topics, particularly focusing on the
impact of diversity on innovation, patent behaviour, and other measures of firm
performance. This, and work in other European countries, suggests that similar
effects are at work;

It is often hypothesised that immigration reduces
the incentive for employees to train native workers. However, in the US, Jennifer
Hunt shows that immigration increases the educational attainment of natives;
she hypothesises this is because of increased competition in the labour
market. Meanwhile, NIESR research for
the Migration Advisory Committee found that "rather
than migrants substituting for home-grown talent, there is evidence of
complementarities between skilled migrants and skilled resident workers"

while, looking at the macro-level impacts on
growth, and explicitly putting the impact of immigration in the same analytical
framework as that of trade, a recent paper by Ortega and Peri found that,
looking across countries, the positive impact of immigration on growth has been
very large. Indeed, they find that it is considerably larger than trade.
Crucially, the channel through which immigration increases growth is through
its impact on total factor productivity, which would not be expected in the
standard model.

This
research agenda is still in its infancy; we still do not know precisely the
channels through which immigration impacts on growth. Nor will we ever be able
to put precise numbers on it, any more than we can identify the contribution of
Britain's history as a trading nation to our current prosperity. But we do know
enough to set a clear direction for policy.

So what should
we do? It is simply not credible for the
Prime Minister to claim that the UK is "open for business" and for
the Chancellor to say that he is prepared to take the "difficult
decisions" to boost growth, while at the same time making the primary
objective of immigration policy the reduction of net migration; and putting the
implementation of that policy entirely in the hands of a Department - the Home
Office - which has no interest whatsoever in growth or productivity. The fact
that the Minister for Immigration regards a fall in the number of student visas
issued - that is, a fall in British exports - as a policy success - is a
damning indictment of the administration of current policy.

So the
first priority should be simply to make clear that immigration, like trade, is
indeed central to making the UK open for business, and hence to our growth
strategy. The next step would be then to examine each aspect of immigration
policy - but in particular those relating to students, skilled workers, and
settlement - with a view towards reorienting them towards growth.

We should
start by reversing the most obvious policy errors made by this government. The most egregious of this was the abolition of
the Post-Study Work Route., which allowed foreign students to stay on after
graduation to look for a job. This initiative was introduced by the previous
government, based on two observations:

the success of Silicon Valley, in particular, and
high-tech US companies in general, relied heavily on individuals who came to
the US to study but stayed on to work (and in some cases, set up their own
businesses)

that, for the brightest and most motivated
foreign students, the possibility of being able to remain in the country for a
period after graduation to work was a significant draw.

The
abolition of the PSWR was a major own goal; it means that foreign students who
want to stay on here and try to build a career or a business find it much more
difficult, if not impossible. Since such people are, almost by definition,
likely to be relatively well educated and motivated, English speaking, at least
partly integrated into UK society already, and so on, they are precisely the
sort of people we want on both economic and social grounds. Of course some will
fail; they will end up unemployed or doing low-skilled jobs. That is the nature
of immigration; not all immigrants succeed, just as not all native-born entrepreneurs do either.

There are
many other sensible changes, major and minor, that are required. But in my
view, more important than specific policy changes is a change of attitude and
mindset on the part of government and policymakers. If we want to be serious about growth, we
will need to be positive about migration.

17 comments:

This is v. good. You need to send this to David Goodhart ASAP with an urgent please read stamped on it in big bold letters. Last night on Newsnight he blithely opined that the 'immigration debate was over with a national consensus around net migration of 120K or so, a position he personally supported with enthusiasm.' Whatever one may think of Demos, on this topic it is not liberal.

"We still do not know"Despite a lot of research, there is no strong evidence that mass immigration to the UK improves GDP per capita, employment outcomes or wages for natives (and there is some evidence that it has a negative effect). At best your arguments are based on anecdotal evidence, wishful thinking and some (biased or non-transferable) research from other countries e.g. Peri's research shows an association between immigration and growth but exclusively for oil rich states and ignores the obvious fact that the richer a country becomes the more immigrants it attracts.

I would accept some immigration and specific types of immigration can be good, but this does not mean that more is better or that net immigration of 100,000 would necessarily be worse than 200,000.

Some rather odd assertions there. Would you say the evidence that trade is good for UK GDP per capita is stronger or weaker than for immigration? Your point on Ortega/Peri is (obviously) wrong: the paper has several lengthy discussions of endogeneity.

The Ortega/Peri claim that all GDP per capita increases that had been previously attributed to trade were actually due to immigration is even odder.

There are probably some UK GDP per capita increases due to the 'batting average' effect but is there evidence of native GDP per capita increases?

You don't mention research showing the opposite (Orefice (2011)?).

Ortega/Peri do discuss endogeneity e.g. with trade, institutional quality. However how do you determine if increasing immigration increases GDP per capita or increasing GDP per capita leads to more immigration (as the destination becomes more attractive).

I don't think you understand the definition of endogeneity or how you deal with it in econometrics. The reverse causality between income and migration is precisely what Ortega and Peri are talking about when they discuss the endogeneity problem. You may think their identification strategy unconvincing, but saying they haven't addressed it simply shows you haven't understood the paper.

You didn't answer my specific question: would you say the evidence that trade is good for UK GDP per capita is stronger or weaker than for immigration?

They do ignore the fact that immigration tends to be from poorer to richer countries and therefore there is net immigration between 2 countries with different GDP per capita. They use instrumental variables based on common language and country proximity between countries that they fit to foreign born. However their openness to immigration IV is very poor at estimating the composition of foreign born and net immigration between individual countries. It is flawed and so is their anaysis and conclusions.

Working out which factors affect UK GDP per capita and their relative strengths is very difficult.

I would say that high numbers of regular, irregular and temporary migrant workers is very likely to lead to an underestimate of the real working population and therefore show a higher GDP per capita (for the same GDP).

Similarly, if migrants are more likely to be in work (e.g. due to age and employability) or to have better jobs (e.g. due to selection of skilled migrants) then GDP per capita is likely to be higher. However it is possible that GDP per capita of the native population is lower than what it would otherwise have been.

As you are aware the availabilty of cheap labour discourages productivity improvements that would otherwise have increased GDP per capita.

As you haven't replied, let's skip to the end of the Peri/Ortega discussion.

There appears to be a strong link between gdp per capita (ppp) and the percentage of foreign born. It seems likely that richer countries let in more migrants e.g. wealth attracts migrants and government policy in wealthier countries is more likely to be immigrant friendly.

Peri/Ortega take some variables like distance between countries, common language and colonial ties and fit this to foreign born data to create an equation that isn't a bad fit to the percentage foreign born. Unsurprisingly this has an ok fit with gdp per capita.

The question is then whether this equation actually means that immigration is a result of these factors or not. If it is and the factors are not affected by gdp per capita then it could mean that immigration increases gdp per capita rather than the reverse.

Unfortunately the equation may fit total foreign born but not the actual nationalities. As the equation is based on adding up the likelihood of immigration to a country from every other country, it means the whole basis of their argument is flawed.

As for the Peri/Ortega trade v immigration effect on gdp per capita. As they point out, this is due to foreign born being more dependent on common language than European colonial ties while trade is the reverse.

So which languages are spoken by more countries. In order, English, French, Arabic and Spanish, and over 130 countries speak at least one of those as an official language. Three are linked to european colonialism and have below average gdp per capita. Arabic speaking countries have an above average gdp per capita, mainly due to oil. Oil producing countries do tend to have higher gdp per capita and a high percentage of foreign born. Guess the direction of the causal link.

I didn't find any of these critiques particularly convincing. But I passed them on to the authors, who have responded. Personally, I don't find cross-country regressions probative in themselves; but this one seems considerably more robust than most, and adds to the extensive other theoretical and empirical evidence in my article. So your critique doesn't seem very persuasive to me.

Still waiting for an answer as to whether you think trade or migration is more beneficial to the UK in GDP per capita terms, and what the evidence is either way. If you want to say you don't know that's fine, but that in itself is quite revealing, I'd say. Authors responses below

1) The association between immigration and growth is exclusively for oil rich states. FALSE. The results are robust to excluding those countries. In some of our models we also control for natural resources and several other land quality variables, besides institutional quality of the receiving country.>> 2) The analysis ignores the fact that immigrants are attracted to high-income countries. FALSE. That is the point of the instrumental-variables estimation. Our identification strategy is based on the empirical observation that the cost of migration decreases with distance between the origin and destination countries, both in a geographic and in linguistic sense. This is unrelated to the income level at the receiving country. Hence, a plausible approach to identifying a causal effect.

3) They ignore the fact that immigration tends to be from poorer to richer countries. FALSE. This is a feature of the data that we use, which, of course, is the basis for our estimates.

4) As you are aware the availabilty of cheap labour discourages productivity improvements that would otherwise have increased GDP per capita.RESPONSE This is an empirical question. The answer may be complicated and may well be context-dependent. Our results suggest that this is not thecase. We find that immigration leads to higher labor productivity and TFP, which may be the result of higher (not lower) investments in physical capital and technology.

5) Unfortunately the [gravity] equation may fit total foreign born but not the actual nationalities. As the equation is based on adding up the likelihood of immigration to a country from every other country, itmeans the whole basis of their argument is flawed. FALSE I don't know where Gary got the idea that the gravity equation does not predict well bilateral migration shares by origin. We have not done this exercise. So I do not know the answer. My conjecture is that such a gravity relationship must hold also for each country of origin. After all Mexicans mostly migrate to the US (short geographical distance) and to Spain (short cultural distance).

At any rate it is not true that the relevance of the instrument in our application requires being able to predict the bilateral migration shares by origin. Our key explanatory variable in the regression of interest is the overall migration share.

6) As for the Peri/Ortega trade v immigration effect on gdp per capita. As they point out, this is due to foreign born being more dependent on common language than European colonial ties while trade is the reverse. FALSE. We think the reason why the migration share has a more significant effect on income per capita than the trade share is a measurement issue. Measuring the increase in a country’s labor supply due to immigration is relatively straightforward. Measuring the effect of international trade on firms’ increasingly global production plans is much more complicated. The trade to GDP ratio may be too rough a measure. In particular since it is based on gross trade flows it does not adequately account for the rise in the use of imported intermediate goods.

7) The number of patents from immigrants in the US has been used tosuggest the benefits of immigration but the relationship is unclear. TRUE. Not all patents are potentially productive and this may be an increasing problem. We don’t dispute this. Our exercise is just tryingto tease out what is behind the productivity effect that we find. Our estimates suggest that immigration leads to higher patenting, which may be one of the channels that lead to the long-run increase in productivity. But we don’t claim that this is the main channel. We also note that our data is for year 2000, which precedes the explosion in patenting activity.

Lets start with a quote from another paper by Peri and Ortega which looked at annual migration flows over a couple of decades and found:"confirming previous literature (such as Mayda 2010 and Grogger and Hanson 2011), we show that destination income per capita is a key determinant of migration choices"http://ftp.iza.org/dp6655.pdf

As would be expected, the direction of causality seems to be high income per capita results in higher immigration. Spain being a very good example of low immigration followed by economic boom followed by high immigration.

I won't go through all the contradictions/errors in their responses, but I will deal with the most important one covered in responses 2) and 5).

Contrary to their claims, they did look at bilateral migration shares by origin, it did not fit well, and this is very important as it undermines the story behind the IV/gravity equation.

Their sections covering diversity and emigration show that their instrumented foreign born (based on distances between countries etc) may fit the total foreign born but not the origin of those foreign born. To quote:"Ideally, we would like to use our gravity predictors for bilateral flows to build an instrument for the diversity index as well. In practice the gravity model delivers a predicted diversity index that is a poor fit for the index calculated using actual data."

If the underlying story justifying the IV/gravity equation does not hold true, then they may as well have fitted the 20 longest rivers in each country to the total foreign born, and claimed that this is unrelated to the gdp per capita, and therefore higher immigration is responsible for higher gdp per capita.

The number of patents from immigrants in the US has been used to suggest the benefits of immigration. However you need to understand some of the underlying causes.

Just over a decade ago the US made it easier to patent software ideas e.g. displaying an animation of a page turning when you turn a page in an ebook. There has been a lot of debate on whether this has helped or hindered innovation but it has certainly been a boon for patent trolls.

There has been a large increase in patents and many companies have moved from real innovation and R&D to having patent factories that try to patent anything. It is not particularly innovative and intellectually rewarding but it created need for a lot of cheap degree educated workers to do the donkey work. Some companies have used H1B visas to get cheap degree educated workers to do the work (often led by experienced US workers).

For example, Microsoft got its 5000th patent in 2005 after about 30 years in business. In 2008, it hit 10,000 and now gets 3,000 to 4,000 a year.

The detail on which the conclusions are based virtually ignore the effect of unemployment on the local population,such as the creation of 'No ambition' ' not worth studying there are no jobs. This is of course the true reason for the dependency society.Also the readily available cheap labour creatde by immigration reduces the need for Employer innovation, and experience of the ost war years would suggest the investment for improving productivity,Then there is the undoubted problem of Social unrest we may have seen some with the recent riots, but that may well be only the fore runner of what is to come unless Employment opportunities are improved for indiginous British people.

As would be expected, the direction of causality seems to be high income per capita results in higher immigration. Spain being a very good example of low immigration followed by economic boom followed by high immigration.

I won't go through all the contradictions/errors in their responses, but I will deal with the most important one covered in responses 2) and 5).

Contrary to their claims, they did look at bilateral migration shares by origin, it did not fit well, and this is very important as it undermines the story behind the IV/gravity equation.

Their sections covering diversity and emigration show that their instrumented foreign born (based on distances between countries etc) may fit the total foreign born but not the origin of those foreign born. To quote:"Ideally, we would like to use our gravity predictors for bilateral flows to build an instrument for the diversity index as well. In practice the gravity model delivers a predicted diversity index that is a poor fit for the index calculated using actual data."